Why Piketty’s inequality arguments don’t apply to Ireland

Preconceived notions about income distribution don’t take into account the facts

Despite the swooning over French economist Thomas Piketty, little of his analysis and conclusions on income inequality actually apply to Ireland. (Photograph: Ed Alcock/The New York Times)

If you are ever unlucky enough to be spending some leisure time with an economist, a way of livening up the proceedings is to challenge him or her on the profession’s use of data. Actually, this can be interesting across many walks of life - to be fair to economists, the use and abuse of numbers is not confined to the dismal science.

In economics, the use of mathematics and statistics is ubiquitous. Vast resources are devoted to compiling huge datasets and their analysis. Millions of charts are drawn every day; the numbers are tortured using fancy statistical techniques of ever increasing complexity. We hear a lot about ‘big data’ but economists have been familiar with the concept for decades. These days, if you are unfamiliar with how the spectral density function relates to the Fourier transform of the autocorrelation function you simply haven’t been paying attention in class.

Ask your economist friend one simple question. How much of this effort has actually added to our knowledge about the way the world works? In particular, has any major (or minor) economic controversy ever been settled by any of this analysis of data? Most importantly, has anyone ever changed their mind as result of statistical analysis?

On the rare occasion that we approach something with an open mind, with an awareness that we don’t know the answer, a study of the data can be enlightening. Usually however, minds have been made up a long time ago and are all too often sealed when it comes to allowing evidence to matter. The role that ideology plays in economics is a well-known theme but many outsiders would probably be astonished by the viciousness of ideological warfare still indulged in by many practitioners. Again, to be fair to economists, much public political and economic debate is conducted without recourse to any evidence whatsoever. Where and how we acquire our deeply held beliefs is another matter entirely, one mulled over by philosophers for centuries but still, for the most part, a complete mystery.

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The debate over income and wealth inequality is a small example. By and large, the Irish media, economics establishment and wider commentariat all swooned when Thomas Piketty hit town. Here was data that confirmed what we all “know”: inequality is high and growing. Something, as a result, needs to be done. Actually, no. But the fact that data suggests that little of Piketty’s analysis and conclusions apply to Ireland is neither here nor there.

Yesterday, the ESRI published the latest in a long line of studies on income distribution in Ireland. The results are fascinating. They are, for the most, in direct contradiction to what Ireland’s “Serious People” all believe about Irish inequality.

The key to understanding how Ireland deals with inequality lies, unsurprisingly, with a proper analysis of how the tax and welfare system works. The welfare system exists, in part at least, to reduce inequality: just how successful it performs this task is an empirical matter.

In the US, for example, much of the post-Piketty debate has been about his almost exclusive use of data, globally, that takes no account whatsoever of the tax and benefit system. Such an approach might be appropriate in the US where there really isn’t that much redistribution, at least compared to other countries. It makes no sense in Ireland.

Things are very different in Europe, where welfare systems are much more supportive. The ESRI’s John Fitzgerald has drawn on a variety of sources to show how inequality, conventionally measured, has risen, sometimes sharply, in countries like Ireland, Spain, Portugal and the UK. The rise was particularly notable during the financial crisis. But all of this is only for incomes measured before the effects of taxation and welfare payments.

When we adjust for these, we see the system has worked as intended: inequality has fallen, sometimes dramatically. In Ireland’s case, pre tax and welfare, we have one of the most unequal income distributions; post tax and welfare we have less inequality than France, Spain, Portugal or the UK, for example. As Fitzgerald says, the effects of Irish public policy are “exceptional”: most countries saw inequality rise during the crisis with only a partial mitigation from the tax and benefit system.

It is a myth that our taxes have had to rise solely because of the banking bailout. To quote the ESRI: “maintaining the welfare system unchanged, in the face of a huge increase in numbers depending on the system, imposed a very big burden on the public finances….social welfare payments went from 13 per cent of GNP in 2007 to 20 per cent in 2011” (they are currently around 17 per cent).

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